MFRS15 Revenue from Contracts with Customers (Part 1) PDF

MFRS15 Revenue from Contracts with Customers (Part 1) Dr Dalilah Aziz 1  Lecture Outline Introduction The 5-step model (recognition and measurement of revenue) Examples Construction Contracts 2 ...

MFRS15 Revenue from Contracts with Customers (Part 1) Dr Dalilah Aziz 1  Lecture Outline Introduction The 5-step model (recognition and measurement of revenue) Examples Construction Contracts 2  Introduction MFRS 15 establishes principles for MFRS 15 supersedes: (a) MFRS 111 reporting useful information to users of Construction Contracts; (b) MFRS 118 financial statements about the nature, Revenue; (c) IFRIC 13 Customer Loyalty amount, timing and uncertainty of Programmes; (d) IFRIC 15 Agreements for revenue and cash flows arising from an the Construction of Real Estate; (e) IFRIC entity’s contracts with customers in 18 Transfers of Assets from Customers; the course of the and (f) SIC-31 Revenue—Barter entity's ordinary activities. Effective date: 1 Transactions Involving Advertising January 2018 Services. 3  Scope Applies to all contracts with customers except for: – Lease contracts (MFRS16) – Insurance contracts (MFRS17) – Financial instruments (MFRS9) – Other contractual rights/obligations (MFRS10, MFRS11, MFRS127, MFRS128) – Non-monetary exchanges between entities within the same business to facilitate sales 4 What is revenue? 5 Revenue: Income arising from entity's ordinary course of business activities ( e.g. Sales, Turnover) 6  Recognition Core principle in MFRS 15 is that revenue is recognised to depict the transfer of goods or services to a customer in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services The transfer is evidenced by the transfer of control Revenue is recognised in accordance with a standard approach - The 5-step revenue model 7  Example Machinery to be built and delivered in 6 months. Customer paid full price (RM150,000) today. When should the revenue be recognised? 8  The 5-step revenue recognition model Identify the contract(s) with a customer 1 Identify the performance obligations (PO) in the contract(s) 2 Determine the transaction price (TP) 3 Allocate the transaction price to performance obligations in the 4 contract Recognise revenue when (or as) the entity satisfies a performance 5 obligation 9  STEP1: What is a contract & what are its characteristics? Contract is an agreement between two or more parties & it creates enforceable rights and obligations Contract may be written or in oral form It must be enforceable based on local legislation A contract may be a combination of interrelated contracts that must be accounted for together (substance over form) Contract may also be modified, amended or changed in terms of for example price, scope, etc. 10  STEP1: Identifying the contract (Recognition criteria as per para 9, IFRS 15) 1. Approved contract and both parties 2. Each party’s rights 3. Payment terms committed to can be identified can be identified perform obligations 4. Contract has 5. Collection is commercial probable when it is substance (affect due entity’s CFs) MFRS 15 Illustrative Example 4 11  STEP2: Identify performance obligations (PO) What are POs? Performance obligation (PO) is a promise in the contract to deliver to customer either: Distinct good or services Series of distinct goods or services (e.g. monthly cleaning/accounting services) PO can be both explicit (in the contract) and implicit (based on practices or policies) If there is no transfer (resources) to customer then there is no PO 12  STEP2: Identify performance obligations (PO) At contract inception, crucial to note whether there are multiple goods or services or whether there are separate and distinctive performance obligations. Goods and services are distinct if the customers can consume them on their own without affecting other performance obligations that the entity promises. Each transaction can be looked at as a 'standalone'. For complex transactions, it is necessary to break a transaction down into its component parts. Example: transfer of goods and the provision of future servicing vs. selling a machine with software MFRS 15 Illustrative Example 11 (Case A) 13  Example 1 Skyward plc builds aircraft for the cargo and postal industries worldwide. It has been contracted to build three large cargo aircraft for Postal Europa Group (PEG). Skyward plc is to build the aircraft and is contracted to deliver them to PEG as each one is completed. It is expected to take six months for the construction of each aircraft, with the total time required therefore being 18 months. Identify the performance obligation(s) in the contract. 14  Skyward plc is contracted to build and supply three aircraft. Each aircraft is a distinct good that is to be delivered to PEG once it has been completed Example and, prior to delivery, PEG 1 cannot use or control the aircrafts. The performance obligations in this case are the delivery of each of the individual aircraft at six-month intervals. 15 STEP3: Determine transaction price (TP) The amount an entity Transaction price is the has the right to receive expected amount for under the contract for promised delivering the goods or goods/services services Does NOT include It may be amounts collected on variable/fixed behalf of third parties 16 STEP3: Determine transaction price (TP) To determine the transaction price for fixed amount, or variable portion the performance obligation promises cash or non-cash forms the entity must consider whether TP time value of money includes: expected value (probability weighted Variable consideration could be amounts) or estimated using: most likely amount in a range of different outcomes 17  Example 2 A car retailer offers its customers a choice of paying for a car at its cash price today, 1 January 20X7, of RM17,150, or to pay nothing today and make a single payment of RM20,000 in two years’ time. The car retailer has calculated a finance cost of 8% applies to the transaction. A customer purchased a car on 1 January 20X7 and chose to pay RM20,000 on 1 January 20X9. How is the sale of the car accounted for in the year ended 31 December 20X7? 18  Example 2 Revenue recognised: RM17,150 Finance income: RM1,372 Carrying amount of receivable: RM18,522 The revenue recognised is based on the price of the car had the transaction been settled immediately in cash. The difference between this price and the amount receivable on 1 January 20X9 represents finance income which is recognised across the two-year period before payment is made. 19  The objective when allocating the transaction price is for an entity to allocate the transaction price to each STEP4: performance obligation (or Allocate distinct good or service) in an amount that depicts the transaction amount of consideration to price (TP) which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer. 20 STEP4: Allocate transaction price The transaction price is allocated to each distinctive performance obligation specified in the contract. If it is possible to establish a stand-alone transaction price, then the entity may estimate it. 21  Example 3 A mobile phone company gives customers a free handset when they sign a two-year contract for the provision of network services. The handset has a stand-alone price of £800 and the contract is for £60 per month. 22  Example 3 Under IFRS 15, there are two performance obligations: the provision of the handset to the customer, which is satisfied when control of the handset transfers to the customer, and provision of the network services over the two years. Some revenue must be recognised on delivery of the handset to the customer because this constitutes satisfaction of the first performance obligation. The remainder is recognised as network services are provided. 23 Step 5: When to recognize revenue? Revenue is recognised when PO is satisfied It is deemed satisfied when the goods or services is delivered to the customer i.e. when the control over the goods or services have been transferred from the company to the customer Over time – revenue is thus Performance obligations can be recognised gradually over the satisfied: contract period – not when the contract is completed OR 24 Step 5: When to recognize revenue? Performance obligations At the point of time – revenue is thus recognised at this point can be satisfied: Thus, timing of performance obligation, payment has impact on how a company recognises its revenue Most common are cost-to-cost and units of delivery methods If over time: Objectives of methods is to measure extent of progress in terms of costs, units or value-added 25  Step 5: Recognise revenue When to recognise revenue? Over time, if meet one of these criteria Otherwise, point in Customer Performance does time Performance simultaneously not create asset creates or enhances receives and with alternative use an asset that consumes benefits and entity has right customer controls as entity performs to payment 26  Prime Supplies Sdn Bhd sells printers on credit for RM4,000 each when the manufactured cost was RM2,000 each. Prime offers its customers a combined contract for RM4,800 which includes the provision of maintenance Example cover for two years. The cost of manufacture remains the same 4 at RM2,000 and the cost of supplying maintenance is RM250 per machine per year. Normally customers could purchase separate maintenance cover from other suppliers for 2 years for RM1,000 per machine. 27  Example 4 On 1 January 2021, Prime sold a customer a combined contract for RM4,800 which includes the provision of maintenance cover for two years. The customer request for 1st maintenance service on 30.9.2021 and subsequently 2nd maintenance service on 31.7.2022. Prime accounting year ends on 31 December. Account for the above events. 28  Example 4 The normal selling prices are The contract is for Supply of printer RM4,000 two separate service obligations Supply of maintenance with different RM500 in Year 1 timing of the services and so the Supply of maintenance revenue has to be RM500 in Year 2 apportioned between the Total services provided RM5,000 contracts and then recognised as the Combined price RM4,800 individual services are provided. 29  Example 4 Supply of printer = This shows that Prime is RM3,840 4,000 X 0.96 selling at 4,800/5,000 or 96% of the normal price Supply of i.e. 4% below normal maintenance in Year RM480 selling price. Each 1 = 500 X 0.96 component part of the Supply of contract is reduced by 4% maintenance in Year RM480 as follows: 2 = 500 X 0.96 Combined price = RM4,800 5,000 X 0.96 30  Journal entries for the year ended 31.12.2021 (when contract is signed) 1.1.2021 - Recording of a printer sale and maintenance package Dr Trade receivables RM4,800 Cr Sales revenue RM3,840 Cr Deferred revenue (Liability) RM960 1.1.2021 Recording costs of sales of printer Dr Cost of goods sold RM2,000 Cr Inventory RM2,000 31  Journal entries for the year ended 31.12.2021 (when 1st maintenance service is performed) 30.9.2021 Transferring accrued revenue to service revenue when 1st maintenance service is performed Dr Deferred Revenue RM480 Cr Sales Revenue (maintenance) RM480 30.9.2021 Recording cost of 1st maintenance service Dr Cost of goods sold (maintenance) RM250 Cr Bank / Creditor RM250 32 Extracts financial statements for the year ended 31.12.2021 Extracts – Statement of Comprehensive Income for year ending 31.12.2021 Revenue : Printer Sales RM3,840 Service Sales RM480 RM4,320 Cost of sales: Printer cost RM2,000 Maintenance cost RM250 RM2,250 Net profit RM2,070 Extracts – Statement of Financial Position as at 31.12.2021 Current liabilities: accrued revenue RM480 33  Journal entries for the year ended 31.12.2022 (when 2nd maintenance service is performed) 31.7.2022 Transferring accrued revenue to service revenue when 2nd maintenance service is performed Dr Accrued Revenue RM480 Cr Sales Revenue RM480 (maintenance) 31.7.2022 Recording cost of 2nd maintenance service Dr Cost of goods sold RM250 (maintenance) Cr Bank / Creditor RM250 34 Extracts financial statements for the year ended 31.12.2022 Extracts – Statement of Comprehensive Income for year ending 31.12.2022 Revenue : Printer Sales - Service Sales RM480 RM480 Cost of sales: Printer cost - Maintenance cost RM250 RM250 Net profit RM230 Extracts – Statement of Financial Position as at 31.12.2022 Current liabilities: accrued revenue - 35  Construction contracts In a construction contract, the Methods of measuring performance performance obligation is delivered over a obligations satisfied over time: period of time. Units of delivery: on the basis of the value to the customer of the goods or services transferred. Example: surveys of performance completed, appraisal of units produced. Cost-to-cost: on the basis of entity’s input such as labour hours, resources consumed or costs incurred. If using cost- based method, the costs incurred must contribute to the entity’s progress in satisfying the performance obligation.  Example 5 Binaan Sdn Bhd, a Contract price RM20,000,000 company specializes in the construction of Cost estimated commercial buildings to complete the applies the percentage contract of completion method of revenue recognition. Direct labour RM4,250,000 Binaan Sdn Bhd measures progress toward Materials and completion in a cost-to- payments to RM8,750,000 cost basis. The company subcontractors has started the work on a contract at the beginning Indirect costs RM2,000,000 (RM15,000,000) of financial year 2019. The information relating to the RM5,000,000 contract is as follows: 37 The following information was obtained at the end of the first year of work relating to the contract: Billings to date RM11,250,000 Cost incurred to date Direct labour RM2,320,000 Materials and payments to subcontractors RM3,240,000 Indirect costs RM965,000 RM6,525,000 The above costs included mechanical and electrical materials which have been stored on the job site but yet to be installed that costs RM525,000. The billings collected for the project amounted to RM9,500,000. 38 Percentage of Costs incurred to date RM6,525,000 completion on the Less materials on job site (RM525,000) contract at RM6,000,000 the end of 2019 based Percentage of completion = Costs incurred to date / on cost-to- Total estimated costs cost RM6,000,000 / RM15,000,000 = 40% method; 39 Amount of gross profit on this contract at the end of 2019 Revenue 40% X contract price RM20,000,000 RM8,000,000 Total costs incurred to date (RM6,000,000) Gross profit RM2,000,000 Journal entry to record the income for 2019 Dt Progress billings RM8,000,000 Ct Revenue from long-term contracts RM8,000,000 40 Extracts – Statement of Financial Position as at 31.12.2019 Current Assets Accounts receivable RM1,750,000 Being the billings to date RM11,250,000 less the amount of billings collected during the year of RM9,500,000 Current liabilities Progress Billings (Billings in excess of contract costs and RM3,250,000 recognized profit) Being the billings to date RM11,250,000 less the revenue recognized at RM8,000,000 41